New Law Expands Uses for 529 College Savings Accounts

The new option for loan payments may seem odd because the main goal for saving in a 529 account is to avoid borrowing for college in the first place. And 529 rules allow an account’s beneficiary to be changed to another family member at any time. So extra cash can easily be reallocated to another student to help pay for college expenses.

But despite the best-laid plans, families — especially those with multiple children attending college — may find themselves with both “leftover” 529 funds and student loans, said Mark Kantrowitz, publisher of Savingforcollege.com. He recently discussed strategies for using 529 funds to pay student debt.

The new loan payment option can help in multiple scenarios — some of which may seem complex, but are relatively common, Mr. Kantrowitz said. Say a family has several children, each with separate 529 accounts. If a younger sibling attends a less-expensive college and does not need the full balance in the account, the family could use the money to help pay down the student debt of the older sibling.

Students could also end up with “excess” 529 money if they graduated from college in three years instead of four, perhaps by taking summer courses or earning advanced-placement credit.

Students may also have to borrow unexpectedly, say, if generous grandparents mistakenly run afoul of federal student aid rules, Mr. Kantrowitz said. Money saved in a grandparent-owned 529 account does not affect a student’s financial aid eligibility while sitting in the account. But once withdrawn, the “distribution” counts as student income, and can reduce the student’s eligibility for need-based aid by as much as half of the withdrawal. (Grandparents often own the accounts in their own names, so they can meet the requirements for income tax deductions offered by some states for 529 contributions.)

One way to avoid that happening is to wait until January of a grandchild’s sophomore year to withdraw funds, Mr. Kantrowitz said. Because the federal aid application uses income from the prior two years, waiting will mean that no subsequent year’s financial aid eligibility will be affected (assuming the student graduates in four years). The student may have to borrow for the first three semesters. But later, under the new rule, $10,000 from the grandparents’ 529 fund can be used to help repay the debt.

“The Secure Act,” he said, “provides families with greater flexibility in spending 529 plan money.”

The College Savings Plans Network says there are about 14 million open 529 accounts holding an average of $25,000 each.

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